Analyzing and Managing Fiscal Risks: Best Practices

1. Analyzing and Managing Fiscal Risks:Best Practices Johann Seiwald Fiscal Affairs Department International Monetary Fund June 28, 2016

2. Motivation for the Paper Advanced Economies: Public Debt (2007-2016, Percentof GDP) Spring 2016 37% of GDP Spring 2007 Source: Fiscal Monitor Database and staff estimates. 2

3. Motivation for the Paper Emerging Economies, Excluding China: Public Debt (2007-2016,Percent of GDP) Spring 2016 9% of GDP Spring 2007 3 Source: Fiscal Monitor Database and staff estimates.

4. Sources of Fiscal Risk Fiscal risks large, under-estimated, non-linear and... Size and likelihood of fiscal shocks by type Source: Bova et al. (2016) 4

5. Sources of Fiscal Risk...highly correlated Contingent Liability Realizations Financial Sector Total Fiscal Cost of CL Realization (% GDP, right axis) Legal NaturalDisasters State Owned Enterprises Private Public Partnerships Private Non-Financial Sector Subnational Government Other 5 Source: Bova et al. (2016)

6. Coverage of Balance Sheet Data (GFS) Fiscal Risk Analysis Disclosure of risks has improved... 2003 6 Source: COFA Database

7. Coverage of Balance Sheet Data (GFS) Fiscal Risk Analysis Disclosure of risks has improved... 2013 2003 6 Source: COFA Database

8. Fiscal Risk Analysis... but quantification remains limited Macro-Fiscal Risk Assets and Liabilities 7 Source: IMF Staff Estimates

9. Fiscal Risk Analysis... as well as risk analysis Specific Fiscal Risks Long-Term Fiscal Sustainability 8 Source: IMF Staff Estimates

10. Fiscal Risk Management Mitigation efforts are undertaken Direct Controls Regulations and Other Measures 8 Source: IMF Staff Estimates

11. Fiscal Risk Management but often ad hocand fragmented Risk Transfer/ Sharing Mechanism Provisioning 8 Source: IMF Staff Estimates

12. Fiscal Stress TestMore integrated analysis of fiscal risks: Iceland Liquidity: Gross Financing (Percent of GDP) Public Debt (Percent of GDP) Baseline Stress: Macro + CL Stress Macro Only Baseline 9 Source: IMF Staff Estimates

13. Fiscal Risk Management ToolkitGuidance on risk mitigation strategies STEP 1: IDENTIFY AND QUANTIFY • Identify risks • Calculate exposure and likelihood • Weigh costs and benefits of intervention STEP 2: MITIGATE • Cap Exposure • Regulate • Transfer STEP 3: PROVISION • Expense • Budget contingencies • Buffer funds STEP 4: ACCOMMODATE RESIDUAL • Account for in setting fiscal objectives 10

14. Fiscal Risk Management ToolkitRisk Matrix

15. Fiscal Risks and Public Debt Ceilings Adoption of debt and other fiscal rules Combination of rules (2014) Evolution over time (1990-2014) BudgetBalance + Expenditure Rules Number of Countries 10 58 10 17 Debt Rule DebtRules 11 Source: IMF Fiscal Rules Database (2015)

16. Fiscal Risks and Public Debt Ceilings Probabilistic assessment of public debt: Illustration European Emerging Market Economy (In percent of GDP) Median forecast 12 Source: IMF Staff Estimates

17. Policy ImplicationsFiscal risk analysis • All countries should seek toincrease their use of probabilistic methods • Low capacity countries should focus on • macro-fiscal sensitivity analysis • financial balance sheet • disclosing explicit contingent liabilities • Intermediate capacity countries should prioritize • alternative macro-fiscal scenarios • full balance sheets • disclosing all contingent liabilities • High capacity countries should concentrate on • disclosing the size and probability of contingent liability realizations • periodic fiscal stress tests 13

18. Policy ImplicationsFiscal risk management • All countries should strengthen their institutional frameworks and centrally manage their risks • Low capacity countries should look to strengthen direct controls and centralize approval of explicit contingent liabilities • Intermediate capacity countries shouldprioritize more effective use of risk mitigation and transfer tools • Advanced capacity countries should build risk exposure into fiscal plans 14